We have already remarked on the growing divergence between the Dow Jones Transportation Average (TRAN) and the Dow Jones Industrials Average (DJIA) on previous occasions. These two stock averages marked the beginning of technical analysis as we know it today. Charles Dow compared the action in the averages over the long term and noticed that price divergences between them tended to develop close to turning points in the economy and the stock market.
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Dow assumed that a marked upturn or downturn in one of the two sectors would soon be followed by a turn in the other sector. He essentially concluded that unless the two sectors were “confirming” each other, trouble was likely brewing under the surface. Over time, a set of technical trading rules was developed based on this observation, which is known as the “Dow Theory” today. To be sure, the Dow Theory is by no means providing fool-proof signals. However, a very large and long-lasting divergence between the two averages is usually not a particularly good sign.
Transportation stocks have steadily weakened since peaking at the last trading day of 2014. The DJIA by contrast has by and large moved sideways since then – click to enlarge.
No firm Dow Theory “sell signal” is in place yet, although one could perhaps regard the DJIA’s dip in late June/ early July as a “minor” DT sell signal. Still, the divergence remains a noteworthy development, especially as it coincides with worsening breadth in the broader market (even in the technology sub-sector, as John Hussman points out in his most recent weekly market report).
However, what prompts us to write about this topic again is an article by Tony Sagami that was recently published at John Mauldin’s site under the colorful title “Sinking Ships, Train Wrecks, and Empty Trucks: My Case Against Transportation Stocks”.
Falling Prices and Tonnages
Mr. Sagami is mainly concerned with explaining why he thinks one should avoid transportation stocks like the plague here (or rather, why he even thinks about shorting a number of them). We find the charts he shows primarily intriguing from a wider economic perspective though.
The first chart depicts Shanghai freight rates for container ships. Container shipping companies are evidently hurting rather badly here, as freight rates have even fallen quite a bit below bunker fuel costs recently.
Shanghai containerized freight index – the cost of shipping a container from Shanghai to Rotterdam. This is quite a stunning collapse – on this particular route, ships will reportedly lose $57 per TEU on fuel costs alone.
As Mr. Sagami explains, a lot of this has to do with the still growing overhang of new ships, as shipping companies have ordered too many new ships at the height of the last boom. The supply glut is already enormous, but seems set to worsen even further in the near future. Trade data from the region suggest that Asian trade remains quite weak as well. In short, the glut in container ships only explains a part of the decline.
Even more interesting is the ATA truck freight tonnage index in the US though. This index doesn’t measure prices, but the actual tonnage of freight hauled on US highways by truckers. The ATA truck tonnage index has turned down rather noticeably in recent months – in fact, its recent peak has coincided perfectly with the peak in the transportation average shown above:
A sharp fall in truck tonnage since the beginning of the year.
This could still turn out to be another short term blip, both in the TRAN and the ATA index. Somehow we don’t think so though. The decline already seems too pronounced for a mere short term blip – and it has lasted longer than a quarter by now.
The US economy is widely seen as the world’s best performing major economy at the moment. However, so far this year most economic data have actually been somewhere between very soft and lackluster. There is one seeming area of strength, namely the labor market. Not only is this a lagging indicator, but the decline in the unemployment rate masks the fact that a great many jobless people are simply no longer counted as unemployed. They have instead become part of the plunging labor force participation rate statistic.
The steep fall in truck tonnage is definitely an alarm signal. It indicates that inventories are already too high relative to demand, something that seems to be confirmed by recent industrial production and retail sales data. Given that tonnage has continued to decline since the end of Q1, one can no longer blame the port strikes either. To be sure, the US economy is not yet signaling an imminent recession. At best though it is muddling through at a very subdued pace. It probably won’t take much to push it over the edge.